No. of Recommendations: 24
Regular REITsters might recall that Yoda was a charter member of the one share club. Several times in 2010 and 2011 I bought/sold one share of REIT preferreds. Today, I renewed my membership in the one share club for 2013. This morning I noticed that one of the $ 25 par issues we owned, had a “stub quote” of ~ $33.00 to sell shares. Stated differently, there were NO shares for sale at a reasonable price.

I placed a sell order for ~ $1.00 above the current buy/ask price. 100 shares immediately filled at that price. What it says is that the buy order on the other side of the trade was not a market order, but apparently a limit order with a very high price. Had it been a market order, it would have filled at $33.00.

Yoda rule number 1 of REIT preferred trading has always been:

“Friends don’t let friends buy/sell REIT preferreds with market orders.”

Yoda has added rule number 2, as a result of today’s trading:

“Friends don’t let friends buy/sell REIT preferreds with limit orders with RIDICULOUS limits set.”

If we had only learned one new trading rule, it would have been a productive day. As it was, the story gets more INTERESTING. Many hours later, on the same sell order, someone bought 1 share at the ask price. This is proof positive IMO that the buyer was NOT the market maker algorithm. It had to be some trader that happened to notice that the ask price was way too high and wanted to get me to cancel my sell order. The trader wanted to enter a sell order at a HIGHER price. He could have entered an order at 1 cent less than my price, but he was not happy with that. He could see that the next order was the $33.00 stub quote. He wanted to sell at maybe a dollar or two higher than my price.

There is NOTHING illegal about the other trader’s order to buy one share. The trader can do that because he uses a platform that has low to zero trading commissions. Most individual investors pay $5 to $10 per trade, so they would NOT trade like this.

What I STRONGLY suspect but cannot prove is that the trader is NAKED short selling. Naked short selling is where you sell shares you do not own or have not borrowed. To my knowledge, REIT preferreds are NOT supposed to be shortable on any platform. NAKED short selling is illegal, but rarely enforced. My guess is that the trader was going to NAKED short sell the shares and then attempt to buy them back at a lower price the same day.

But there’s more!

One minute after the one share trade occurred, somebody bought an additional 100 shares at the same high price.

Ten minutes later, another 200 shares traded at the same high price.

Other than the one share trade, somebody had to place three separate buy orders for these trades. There is no way to say if the trades were done in one account or multiple accounts.

The other remote possibility is that some Algorithmic trading program had a bug and place the three trades without human intervention. Kind of like the Knight trading fiasco on a small scale.

Makes for one of the stranger trading days Yoda has personally experienced in REIT preferred land. . .

Thanks,

Yoda
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Yoda-

that kind of illiquidity makes a good case for not going into those kinds of issues at all.

while we might plan to hold an investment forever, the fact is that there are many reasons we might need to liquidate.... if these antics can happen on a day that the S&P500 hit a 5 year high, I shudder to think how thin the market could be should we ever get another real decline!

JC
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Yoda,

"What I STRONGLY suspect but cannot prove is that the trader is NAKED short selling. Naked short selling is where you sell shares you do not own or have not borrowed. To my knowledge, REIT preferreds are NOT supposed to be shortable on any platform. NAKED short selling is illegal, but rarely enforced. My guess is that the trader was going to NAKED short sell the shares and then attempt to buy them back at a lower price the same day.

I'm very confused by this. REIT preferreds are most definitely shortable. Why wouldn't they be?

Also, while you are making the assumption that the trades weren't a market maker, again I feel compelled to repeat that market makers can and do naked short (legally) specifically for the purpose or limiting one off price spikes (and yes, making money.

Just logged into my broker and looked up these preferred off the top of my head, here is the status:

1) GKK PA --> 200k shares available to borrow (aka, available to short)
2) KIM PH --> 1k shares available to borrow
3) FUR PD --> 15k shares available to borrow
4) RPT PD --> 15k shares available to borrow

Those are the first four I checked.

Obviously being able to (non-naked) short as a retail investor requires the ability to locate a borrow prior to shorting. I can see why this could be harder for some preferred because of their small size, and as you get smaller / less liquid I would imagine shorting would be more difficult. However, my broker allows you to submit an order to short and maintain the order even during times when you cannot find a borrow... you just get a warning that you can't short until a borrow is located so you can't guarantee execution.

Even shorting OTC preferreds should be possible, again, as long as you can locate shares to borrow. I will note that my broker (IBKR) pays you a portion of the lending fees so that they are actively encouraging their clients via a market based mechanism to lend more shares and thus borrow availability is going up, and borrow cost for shorting is going down on their platform.

Thanks,

Ben
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"Just logged into my broker and looked up these preferred off the top of my head, here is the status:

1) GKK PA --> 200k shares available to borrow (aka, available to short)
2) KIM PH --> 1k shares available to borrow
3) FUR PD --> 15k shares available to borrow
4) RPT PD --> 15k shares available to borrow"


Boy, I would sure jump on shorting those 1,000 shares of KIM PH while I still could. That is if I was one of you.

Ju.................st joking!

I love buying illiquid small cap stocks, but there are a few rules to keep from losing your ass.

Among those rules are:

1) Let the illiquidity and resulting volatility to work for you. Easier to do on the buy side because illiquid small caps can really drop to ridiculously low prices near the bottoms and occasionally have been able to let those factors work for me to sell at equally ridiculously high prices a few times.

2) Don't let the illiquidity and volatility to work against you, primarily by never getting into the position of ever HAVING TO SELL one of these thinly traded securities. The easiest ways of having to sell is using margin and I guess shorting could put you in an equally bad position of having to buy.

Yoda's point of using limit orders is a good idea as well.

One of the smartest men I ever knew, SFC Carrasco my Senior Drill Sergeant, once told me, "Just because you can do something, doesn't mean you should!"

I have noticed that the thinly traded illiquid securities seem to drop more in prolonged down markets. Nothing scientific, just I am pretty sure that such under performance happens a lot in down markets.

I wouldn't want to try selling many illiquid preferreds when interest rates start to rise and if I was committed to a large scale portfolio of either bonds or preferreds I would reinvest 2-3% of my interest or dividends each year to protect myself from inflation.
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No. of Recommendations: 6
Ben said: I'm very confused by this. REIT preferreds are most definitely shortable. Why wouldn't they be?

Ben, on some platforms 100% of REIT preferreds are not shortable. They are treated like corporate/muni bonds which are not shortable. A large concern is the illiquidity. The brokerage does not want to let the investor get into a short squeeze position where you literally might not be able to cover the shorts at any price. I had not checked shortability on IB recently, so I was NOT aware they offer it. Have you actually shorted any to verify they will let the trade go through? I will attempt to place a few short trades. I do know that IB has restricted margin on some REIT preferreds. Even though they are NYSE traded issues and should be marginable, IB sets 100% margin requirements. I assume that IB does not allow shorting on these issues, but I will check to determine the status.

Ben said: Also, while you are making the assumption that the trades weren't a market maker, again I feel compelled to repeat that market makers can and do naked short (legally)

Ben, I 100% agree that the Designated Market Maker aka specialist can legally do naked shorting. Can you explain why the DMM which is an algorithm running on a server in Rahway, New Jersey decides to short a single share hours after the last trade? It must be a pretty interesting algorithm to do that. It is possible, I just think it is much more likely to NOT be a DMM algo.

Since specialists have gone the way of the dinosaurs, it is more difficult to find out what is really going on. In the old days, when the NYSE floor was something other than a photo op, you could find out what was going on by talking to the specialist assigned to the stock. Until you or I can see the inner workings of the DMM algo, I suspect it cannot be proven one way or the other.

BLACK BOX WARNING: Even if we stipulate that public investors can short all REIT preferreds, it is certainly NOT a recommended strategy in general. It is high risk, particularly due to their illiquid nature. Plenty of folks would like to force you into a short squeeze if you are short on one of the more illiquid issues.

Thanks,

Yoda
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Hey Yoda,

Ben, on some platforms 100% of REIT preferreds are not shortable. They are treated like corporate/muni bonds which are not shortable.

A side note, you can short Corp bonds on IB as well. Generally they require larger size. Issues I have looked at were 100 bond minimums (~$100k minimum) but IB is forging ahead in a lot of these areas so what is usual is quickly changing.

A large concern is the illiquidity. The brokerage does not want to let the investor get into a short squeeze position where you literally might not be able to cover the shorts at any price.

IMO, there is limited demand at typical retail brokers for this service and that is why they don't bother trying to get decent lending inventory. It's not about protecting people from their loans being called or squeezed... although maybe the increased customer service also makes it not worthwhile.

I had not checked shortability on IB recently, so I was NOT aware they offer it. Have you actually shorted any to verify they will let the trade go through? I will attempt to place a few short trades.

I've shorted a lot of weird stuff on IB, so I have no doubt it will work, but I have not personally shorted a REIT preferred specifically.

I do know that IB has restricted margin on some REIT preferreds. Even though they are NYSE traded issues and should be marginable, IB sets 100% margin requirements. I assume that IB does not allow shorting on these issues, but I will check to determine the status.

I don't think this is right. The margin requirement applies to both short / long margin, but does not affect ability or availability in my experience. I am currently short several issues that are on the 100% margin list. They consume marginable funds like crazy, but IB doesn't care. Maybe other brokers do, IB's margin call engine from what I've seen on the tape is ruthlessly aggressive. They don't give you a "call" they give you a "5% margin" warning email, and then they liquidate you on automatically if you breach 0% margin. They don't care about what you short. They assume that their customers are big boys and read the fine print so I don't think they have reservations here.

There are a lot of things that I think many retail brokers do that have nothing to do with legality (shorting stocks below $4, not trading certain OTC issues, etc), but IB is all driven by their cost model. So they are pretty pure in what they will let you do.

Can you explain why the DMM which is an algorithm running on a server in Rahway, New Jersey decides to short a single share hours after the last trade? It must be a pretty interesting algorithm to do that. It is possible, I just think it is much more likely to NOT be a DMM algo.

Since specialists have gone the way of the dinosaurs, it is more difficult to find out what is really going on. In the old days, when the NYSE floor was something other than a photo op, you could find out what was going on by talking to the specialist assigned to the stock. Until you or I can see the inner workings of the DMM algo, I suspect it cannot be proven one way or the other.


I have no special knowledge of what or why DMM's do what they do. But I do know that not all DMM orders are "computer" generated. If there is some way to make money legally with a DMM's special abilities, they simply seek to find it. Also, you make a reference to the DMM for a specific stock. I believe the DMM exemption for shorting is not for the DMM, it is for ANY registered MM who is doing "bona fide" market making. So I think your ability to talk to the specialist is besides the point. It's not the MM for this preferred that is the only one who can naked short this perferred... it's any MM... this is at least my understanding (could be wrong).

I have some small reservations about the "electronification" of our exchanges and trading, but I have to say, there have been stories of short squeezes, manipulation and various scalping activities by the main traders / MM's on wall street for years before this digitalization. bid/ask spreads used to be 12.5 cents (!!!) at a minimum... do we really want to go back to that time?

Ben -- Not defending the current system. I don't know the answers but have some opinions. For those interested in the mechanics of exchanges I found "Trading and Exchanges" by Harris to be valuable (it's a textbook though, so take that for what it is).
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1) Let the illiquidity and resulting volatility to work for you. Easier to do on the buy side because illiquid small caps can really drop to ridiculously low prices near the bottoms and occasionally have been able to let those factors work for me to sell at equally ridiculously high prices a few times.

Hmmm -- given the short-sales context I wonder if the "sales at ridiculously high prices" were to short-sellers getting desperate to cover their position in an illiquid security (maybe even getting squeezed if their borrow was recalled and they could find no more). Otherwise the investor might surely have waited for better times... a burning urge to sell (due to an equally burning need for cash -- maybe a margin call?) is easier to visualize!-)
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A side note, you can short Corp bonds on IB as well. Generally they require larger size. Issues I have looked at were 100 bond minimums (~$100k minimum) but IB is forging ahead in a lot of these areas so what is usual is quickly changing.

Apologies in advance for my cluelessness, but isn't a typical corporate bond at $10,000 par...? Haven't bought an individual corporate bond in ages (nor shorted any bonds ever -- as opposed to bond ETFs;-), so maybe everything's changed -- but, it does seem to me as if the 100-bond min translates into roughly a "cool million", not just $100k. Is that wrong...?

Now I realize "one... million... dollars" isn't really a huge amount -- http://www.youtube.com/watch?v=l91ISfcuzDw -- but, having left all the "family money" behind in my adult children's hands in the Old Country when I last moved over 8 years ago, I'm only investing what I've been saving ever since, and even with good income and a frugal lifestyle a million's still a lot for me -- couldn't conceive of plonking that much down on one bond short unless I had make-me-illegal-for-trading inside info about the issuer going bust;-)...

IB's margin call engine from what I've seen on the tape is ruthlessly aggressive. They don't give you a "call" they give you a "5% margin" warning email, and then they liquidate you on automatically if you breach 0% margin.

Yep, that's part of why I'm not with IB -- I have a day job so I can't be wired into the market all the time... I try to position myself to fear no margin call even though everything goes against me by a factor of two, but considering that in such extremes brokers (or even the SEC) could conceivably change margin requirements all of a sudden, I can have no certainty there. OH (OptionsHouse) is slightly costlier than IB (and much less flexible: no market but US ones, no futures, &c) but I do expect a normal margin call should I ever stumble into one -- a day or so to wire more cash or at least decide which positions to close. I couldn't sleep well if I was at IB and used any margin at all... and if I self-forbid from using any margin then IB's advantage is slashed down. Which is why I'm with OH and sleep just great at night;-).

I have some small reservations about the "electronification" of our exchanges and trading, but I have to say, there have been stories of short squeezes, manipulation and various scalping activities by the main traders / MM's on wall street for years before this digitalization. bid/ask spreads used to be 12.5 cents (!!!) at a minimum... do we really want to go back to that time?

I love today's tight spreads -- and don't forget the ability to trade less than a full lot at no extra cost, that's magical for the small investor who still wants plenty of diversification!-) If we have to put up high-speed trading's woes as a cost for that, I'm all for it!-)
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Aleax,

Apologies in advance for my cluelessness, but isn't a typical corporate bond at $10,000 par...? Haven't bought an individual corporate bond in ages (nor shorted any bonds ever -- as opposed to bond ETFs;-), so maybe everything's changed -- but, it does seem to me as if the 100-bond min translates into roughly a "cool million", not just $100k. Is that wrong...?

It's $1,000 face for most corporate bonds. No typo. $100k is still a lot for many folks, but I don't think shorting corp bonds is a key strategy to wealth for most retail investors, so I don't think there are any issues. :)

Ben
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